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Aflac Incorporated (NYSE:AFL)

Q3 2013 Earnings Conference Call

October 30, 2013 09:00 ET

Executives

Robin Wilkey - Senior Vice President, Aflac Investor and Rating Agency Relations

Dan Amos - Chairman and Chief Executive Officer

Kriss Cloninger - President and Chief Financial Officer

Paul Amos - President, Aflac

Ken Janke - President, Aflac U.S, Executive Vice President and Deputy Chief Financial Officer, Aflac Incorporated

Eric Kirsch - Executive Vice President and Global Chief Investment Officer

Tohru Tonoike - President and Chief Operating Officer, Aflac Japan

Analysts

John Nadel - Sterne Agee

Yaron Kinar - Deutsche Bank

Nigel Dally - Morgan Stanley

Jimmy Bhullar - JPMC

Tom Gallagher - Credit Suisse

Joanne Smith - Scotia Capital

Randy Binner - FBR Capital Markets

Steven Schwartz - Raymond James & Associates

Operator

Welcome to the Aflac’s Third Quarter Earnings Conference Call. Your lines have been placed on listen-only until the question-and-answer session. Please be advised today’s conference is being recorded.

I would now like to turn the call over to Robin Wilkey, Senior Vice President of Aflac Investor and Rating Agency Relations. Ma’am, you may begin.

Robin Wilkey

Thank you, Marianne. Good morning and welcome to our third quarter conference call. Joining me this morning is Dan Amos, Chairman and CEO; Kriss Cloninger, President and CFO; Paul Amos, President of Aflac; Ken Janke, President of Aflac U.S, Executive Vice President and Deputy CFO of Aflac Incorporated; Eric Kirsch, Executive Vice President and Global Chief Investment Officer. And from Japan we have Tohru Tonoike, President and COO of Aflac Japan joining us.

Before we start this morning, let me remind you that some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although, we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our quarterly release for some of the various risk factors that could materially impact our results.

Now, I’ll turn the program over to Dan who will begin this morning with some comments about the quarter and the operations in Japan. Dan and Kriss will join us and provide further details about our activities and 2013 and 2014 EPS guidance. Dan?

Dan Amos

Okay, thank you Robin. Good morning and thank you for joining us. I am pleased that we met and in many cases exceeded our financial targets for the third quarter. Notably, we believe we are well positioned to increase operating earnings per share about 5% for the year before the effect of currency. At that time, we anticipate operating return on equity will be strong in the range of 22% to 25% for the year before the impact of the yen. We will spend some time talking about our financial and earning guidance this morning, but let me take a few minutes to give you a high level perspective on the operations and how I view our business. I will start with Aflac Japan, our largest earnings contributor. We continue to enhance our distribution opportunities and product offerings in Japan. I’m very pleased with expansion of Aflac Japan’s last agreement which pays and post which commenced in October. This agreement ranks together the Japan the most the largest nationwide distribution network in Japan and Aflac Japan the industry leader in cancer insurance. Both companies will be able to maximize numerous synergies by working together. With respect to our products in Japan I’m pleased with our newest medical offering which successfully launched in August. We expect this product will continue to popular with consumers. The combination of Japan post and the new product we’re allowed is the strong indication of our focus on our higher return third sector products. In regard to Aflac U.S. the sales environment continues to be challenging. The U.S. consumer sentiment hitting it's lowest level in nearly a year. Our job is to be multi-dimensional in our distribution to create a presence where consumers want to purchase our products. We’re working to enhance our sales capabilities both through our traditional sales force and brokers who operate in local, regional and national markets.

In addition we’re currently policing Aflac’s private exchange platform which we believe will provide us with even better access to smaller case market. We’re also creating products that respond to and anticipate the needs of consumers and businesses particularly in the current healthcare environment. With change comes opportunity and we’re positioning Aflac in a way that we should benefit from healthcare reform.

Whether we’re talking about our operations in Japan or the United States as an insurance company our primary mission is to fulfill our obligations to the policy holders at the same time we’re listening to our shareholders and understand the importance of capital deployment. To enhance the predictability of that capital deployment we fortified the level of SMR and taken steps to insulate the capital ratio against factors that connectively impact in the future.

Doing so gives us greater confidence in our ability to target and deliver our profit repay creation amounts from Japan to the United States. Once we know our customer obligations are satisfied our objective is to enhance shareholder value through share repurchase and a growing cash dividend. As we said for many years we believe those are the most attractive uses of capital and those are the avenues we will continue to pursue. In fact in 2013 we initially expected share repurchase to be in the range of $400 million to $600 million we now anticipate purchasing $800 million of shares this year. That means we will be purchasing more than 500 million of shares in the fourth quarter alone. Previously we have communicated our expectation of 2014 repurchase to be in the area of 600 million to 900 million for the year. We now anticipate next year’s range to be 800 million to a $1 billion. I’m also pleased with the action by the Board of Director’s to increase the quarterly cash dividend by 5.7% effectively for the fourth quarter 2013. This marks the 31st consecutive year of increasing our cash dividend. Our objective is to grow the dividend at a rate generally in-line with operating earnings before the impact again.

Overall I’m pleased with Aflac’s position in Japan and the United States the two largest insurance markets in the world. But let me leave you with this thought [ph], you have all heard me say my job is to balance interest of all stakeholders. I think we did a good job for that this year just as we have in the past. I believe we’re going to do it again next year by protecting our policy holders with a strong SMR and returning significant capital through our owners.

So now I will now turn the program over to Kriss. Kriss?

Kriss Cloninger

Thank you Dan. I would like to follow-up with a few comments on how we delivered on those promises and what it cost. You may recall that in the second quarter conference call, I was asked if there was a sense of urgency to stabilize the SMR. My simple answer was yes. And today, I can tell you that we completed several actions during the third quarter to fortify and enhance our SMR as well as to protect FSA earnings and profit repatriation in the future.

Let me take you back to the second quarter of this year. The U.S. Fed made comments that resulted in a spike in U.S. interest rates in May and June. Interest rates in Japan also increased. And by June 30 we have experienced a significant decline in the market value of Japan’s assets categorized as available-for-sale or AFS. As a matter, we went from a net unrealized gain position in the AFS portfolio at the end of the first quarter to a net unrealized loss position in the same category at the end of the second quarter. This mark-to-market decline was the primary factor, because our SMR to decline by 101 basis points to 585 at June 30.

Now, while that SMR result was still within our targeted range, we were concerned that another spike in interest rates whether in the U.S. or Japan would further lower the SMR and make our share repurchase activities more uncertain. The first thing we did was to begin using the policy reserve matching our PRM accounting category in Japan. We used PRM to limit the mark-to-market risk on about $7 billion worth of our Japanese government bonds that were previously held in AFS. While using PRM did not materially increase the SMR during the third quarter, it does provide significant SMR protection against further increases in yen interest rates.

In addition, we executed derivative transactions to reduce dollar interest rate risk. For the use of interest rate collars, we hedged approximately 25% of our total dollar exposure in Japan against the risk of rising interest rates. Then late in the quarter, we entered into a reinsurance agreement, excuse me, which generated an SMR increase of about 115 points and represented the majority of the SMR improvement in the third quarter. While the cost of the reinsurance agreement will lead to about an estimated nickel per share reduction of EPS in 2014 we believe that provided the most cost effective means to increase capital in Japan.

Now, let me discuss some other factors primarily involving investments and other operating expenses that are affecting our 2014 guidance. These factors highlight the reasons why we expect our 2014 earnings growth rate to be somewhat lower than our 2013 growth rate. First, let me describe the investment headwinds. In the third quarter of 2013, we made a deliberate decision to move toward a more conservative asset allocation revising our asset allocation to emphasize yen denominated purchases. At present, we estimate that about 51% of our 2013 Japan cash flows will have been invested in yen with the balance allocated to the dollar denominated U.S. corporate bond program. Because we anticipate continued volatility in the financial markets for some time to come, we expect to allocate 80% to 90% of our estimated 2014 cash flow to yen denominated securities with the balance going to dollars.

In addition, we continue to see very low investment yields in Japan. This change in investment allocation along with assumed investment yields and less new cash flow combines the negatively impact investment income growth by approximately JPY6.9 billion before taxes or about $0.11 in operating earnings per share. Expense headwinds included increase in commission expenses related to an increase in Japan’s consumption tax rate beginning April 2014, which is expected to cost us about JPY2 billion or $0.03 a share in 2014. In addition, we increased our commitment to a multi-year program we referred to as the corporate value enhancement program or CVEP as we may later refer to it which involves a major investment in our business systems and processes to strengthen our position as the leading provider of third quarter products. In total the increased expenses for Aflac

Japan in 2014 excluding the cost of reinsurance agreement and consumption taxes on commissions will be about 8.5 billion yen before taxes or about $0.12 a share.

Like Aflac Japan, Aflac U.S. is increasing it's spending to strengthen service levels for our distributors and customers. This initiative will begin with significant improvements through our enrollment and billing systems. The additional expenditure on this project will likely total that $7.3 million before taxes or about a penny a share. We do have some (indiscernible) wins as we offset some of these costs. We recently modified our U.S. pension plan and retiring medical benefit plans which reduces our liability and will result in lower expenses going forward. The change in both retiring medical and pension plans will lower expenses by about $24 million or about $0.03 per share in 2014.

As Dan mentioned we have upwardly revised our expectations for share repurchase in 2013 and ’14 both of which will benefit EPS growth next year. Additional we expect the majority of our share repurchase activity in 2014 to occur earlier in the year.

The incremental benefits our earnings from the expanded share repurchase program is about $0.12 per share in 2014. We understand that many of the activities we’re undertaking come at a price and the price is a slightly rate of EPS growth in 2014.

Taking all of these factors into account of the yen average is 95 to a 100 yen to the dollar for the fourth quarter in 2013 and continues into 2014 we would expect 2014 EPS to be in a range of $6.28 a share diluted share to $6.52 which is a growth rate of approximately 2% to 5% on a currency neutral basis.

It is important we think that perhaps [ph] all the items are discussed the 2014 EPS growth rate objective would have been comparable with the 2013 EPS growth rate we expect to achieve. More importantly as we look to the future we anticipate the headwinds we face in 2014 will diminish significantly in 2015. We believe all actions we plan for 2014 will ultimately serve not only to protect our policy holders but also benefit recurrence to shareholders.

Now let me turn it back to Rob for some comments on the quarter.

Rob Wilkey

Thank you Kriss. Before we begin with our Q&A this morning I want to take this opportunity to remind you all that we will be hosting our 2014 (inaudible) meeting in Tokyo, Japan on Tuesday, September the 16th but please mark your calendar and we hope to all see you there. We’re going today to go straight into the questioning and to be fair to everybody. Please remember to limit yourself to one initial question and only one follow-up that relates to your initial question. Now we will be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from John Nadel of Sterne Agee.

John Nadel - Sterne Agee

I’ve two questions and I guess maybe more directed to Kriss or Dan. They center around the two bigger items that are headwinds for 2014, I guess you know the infrastructure projects that you’re talking about in particular for Japan for next year. I’m just wondering if you had any discussion internally about redirecting for example some of the incremental spending that you expect to do in the fourth quarter of ’13 around promotions spending that sort of thing toward may be getting a head start on the infrastructure projects instead. In particular, it seems like you have got similar tailwinds around Japan third sector sales growth in over the next one to two years maybe even longer given the medical product rollout and given the Japan cost arrangement. And given, there is also some increasing signs that the Japanese government may yet again adjust deductibles?

Dan Amos

Well, let me – I will let Kriss answer this, but let me just say that it’s an accounting issue. We can’t prepay anything. We have – we can only do it as we actually have the contract working on it and it takes time, but I will let Kriss go into more detail.

Kriss Cloninger

Well, as it relates to the so-called CVEP project, I will make a couple of comments and then I’d like Tohru Tonoike to make some additional comments on this. John, this is a multi-year project. It’s a significant long-term project that we have – we initiated several years ago. For the first couple of years, we were able to absorb the cost of the incremental cost that doing the project planning and some of the initial work within our operating expenses in Japan within the normal earnings increase to guidance. We have reached a point though in the project where we have to ramp up the expenditures for a couple of years to be – to really make solid progress on both the administrative, the marketing and the ITE aspects of this project. I have identified what the ramp up is for 2014. We expect to spend a similar amount in 2015, but that won’t incrementally affect earnings. So it’s not as simple as moving some promotional expenses in the fourth quarter of ‘13 to offset the anticipated expenses for the project in 2014, project simply too big. Tohru, would you like to make some additional comments on CVEP and then we probably need to come back to the sales question.

Tohru Tonoike

Yes. As Kriss pointed out that we have been developing the program during the last couple of years, but OECs of the program, most of our jobs that are of – say what I call the planning and less implementation or a development of the program. But during the 2013, we have increased the level of the program development of the program and then best activity will be higher in the 2014 and then it will be plateaued for the rest of the several years. So yes and as Dan mentioned, the timing of incurring the expenses is tied to the volume the work we put into the program. So we discussed to move the timing, accelerate that work to the extent possible, but there aren’t too much say flexibility available to us on that. So this is as much as we could have done.

Dan Amos

But let me say one other thing, one of the things that’s driving this project to cost more money is as you remember how you all complained about we were slow in putting in rate increases. Our systems couldn’t handle it. We now – this is part of this new project is it we can address that upfront and we are getting it done as quickly as we can for future not so much the past. We feel fine now what we have done in the past. But for the future and Paul is going to make some comments about sales, because he has been over there, he will be moving over there in January.

Paul Amos

Yes. John really quickly I will say that obviously the additional promotion expense is around pushing our third sector products. We clearly deemphasized the first sector and emphasized the third sector. And we are trying to push those products where we fill the launch of our new EVER plan has done at or above expectation and we feel strongly about where we’re going to end up the fourth quarter on the third sector side. So overall I think the coordination of our communication and promotion is critical to the success of the sale and I feel very good about what we’re going to do in that marketplace.

John Nadel - Sterne Agee

And then my second question related to the outlook for investment for the investing of new cash flows, you know I understand that 80% to 90% in JGB is you know for 2014 and I’m guessing that’s obviously going to reduce the new money yield pretty dramatically given where rates are right now. But I’m just wondering you know you’re two years into this build-out of the new investment department with an eye toward a more balanced investment approach overtime. You know and you spend a lot of money on that and it appears the outcome and maybe this is more market driven I would appreciate your comments but it appears the outcome you know after all that spending and build out is that you’re still going to end up investing very similarly to the way you did a couple of years ago.

Dan Amos

Well that is true right now for the short term but take into account all of the things that we have been doing so far. We have addressed the issues with Europe, we have done the colors [ph] we have sophistication now that we would not be able to handle have we not staffed up. If the staffing up for us to buy 80% - 90% of our business in JGB the answer is no. Our staff up is to have a diversified portfolio but we have to take what we’re dealt at the time we have been dealt and we felt the most important thing is to you know again hearing it loud and clear from all of you make sure you get the profits out of Japan and we have had to firm that SMR which cuts down the volatility with the JCB but don’t take this that we like that. We would much rather be much more diversified, we would much rather being doing the things that we told you we’re setting up for but I promise you that this new department that we have setup has capabilities in monitoring that we have to have in place before we can take on some of these. So I’m going to let Eric talk about it but I didn’t feel it was fair for Eric to have to depend what I’m responsible for originally setting up and while we set it up.

Eric Kirsch

Yeah I would just add to that thank you Dan. When you think about the investment in the group, it just simply can’t boil down to as you return higher than it used to because Dan went over so many critical issues that were important to the health and the future of our balance sheet that we were able to address through these investment but I have also add when you look at these returns is a long term right? It's not what you did this quarter, this six months it's the long term. So I would offer to you since the build-out of the team the fact is we have instituted parts not all but parts of our strategic asset allocation. We have $11.5 billion in what we call the hedged corporate bond program that was not there before and it's not for the build-out. We probably would have had that money primarily NJGBs [ph]. So if you just look at that bucket and I will give you just a net estimate on annualized basis, if you look at the incremental yield of those hedge corporate bonds taking out the price repaid for the forwards the incremental expense of the investment team which again is spread out over many different things, we’re just focusing it on this. We’re looking at a net of about a 125 million or so an annuity stream of income and that’s just after two years of building out not that I have got here and started with the 50 extra people, we had to hire them. We’re in the middle of instituting a new technology platform and throughout that period we have addressed and reacted to things that have happened in the market that are critical for the overall company. So I would offer, we have accomplished a lot for that investment and there is more to come. So from a taxable [ph] standpoint we will always be careful to the markets and the needs of the organization.

John Nadel - Sterne Agee

And Eric fair to say that you know the market gives you some opportunities over the coming months to tactically adjust that allocation and you will respond I assume.

Eric Kirsch

Absolutely. The teams are thinking about the markets and our different options all the time. And one last comment as well and Dan touched on this, it shouldn’t be lost that the reduction in our private placements, which is the biggest risk that we have is significant. I think when I got here we were close to 50%. We are now just under 30% of the overall portfolio. And that docket of privates is in much better shape than it’s ever been which helps us to have confidence in the future health of the balance sheet.

John Nadel - Sterne Agee

No question. Thank you very much for the full response.

Operator

Our next question comes from Yaron Kinar of Deutsche Bank.

Yaron Kinar - Deutsche Bank

Hi, good morning everybody. You touched upon the Japan post-deal again this quarter and I want to dig into that a little further if I could. In maybe better understand the opportunity there and I understand that there are 20,000 branches that you now have access to, but at the same time this is potential product has roughly 15%, 16% penetration in Japan already, you have a 50% market share of new sales. So how does that opportunity really play out over the next few years if you could add some color to that?

Paul Amos

Yes, I am going to turn it over to Tohru here in just a second to talk to his perspective on Japan Post, this is Paul, but I will tell you that as Dan called it at the last conference call a game changer, we want to make sure you understand that everything that happens in Japan happens at a methodical and very pragmatic pace. We have amounts that we are opening up a 1,000 additional post office locations beginning in October. And we believe that through the middle to end of next year, we will potentially be looking at products and how we will enhance our cancer plans effectively sell through the Japan Post channel, but we believe over time that product and that will be pushed through that channel in a highly effective manner and we believe it’s something they can be a benefit. We are not ready to commit to any particular numbers based on what are continuing and ongoing negotiations with Japan Post about how that will both be rolled out in terms of the number of branches as well as what the sales targets will be, but Tohru, if there are any additional comments you want to make, we just continue to believe that this is a significant deal for the company and we will have a material impact on our cancer sales.

Tohru Tonoike

Yes, Paul, thank you. And one thing I would like to point out is that the Japan Post network is a huge network and that network happens to have the least say overlap with our existing distribution network. In other words, we have been very good after the promotion of the business in the large metropolitan areas, but relatively not so good in the rural areas. On the contrary, Japan Post network is spread all over the Japan including very rural areas. So we are hoping that having the Japan Post network will help us increase the sales in the areas, which we have not been so strong in.

Yaron Kinar - Deutsche Bank

Okay. And I have one follow-up on that if I could. Looking at the guidance for 2014, basically you are saying without the specific headwinds that you discussed earnings growth itself having the mid-single-digit range. And I guess I was a little surprised to see that that earnings would not have come in stronger than that given the new emphasis on third sector sales and maybe ACA being less of a headwind next year. And just want to hear your thoughts on that?

Dan Amos

Let’s repeat that again, please.

Yaron Kinar - Deutsche Bank

Okay. So if I look at the guidance for 2014, my understanding is that without the specific headwinds that you detailed earnings or EPS growth would have been the 4% to 7% range. And my question is why wouldn’t it have been higher again without the headwinds given the fact that you are emphasizing the more profitable third sector products in Japan and maybe ACA becomes less of a headwind next year as well? Why wouldn’t we see earnings come in a little higher than that?

Dan Amos

Well, it would have been in closer to 4% to 7% if not slightly higher than that. As I pointed out last year, it takes a little bit of time for the effect of the first sector products to earn their way through the financials even though we are writing about 60% to 70% less ways in the last three quarters of 2013 then we wrote in 2012. We still wrote a fair amount in the first quarter of 2013 and we’re still writing a fair amount even though the percentage reduction is high as a percentage reduction is. It's still a larger volume of business than the third sector products. In addition you’ve got some persistency differences between the first sector products, many of which were paid for with the so called discounted advance premium program and when people pay all the premium upfront they don’t tend to laugh because they don’t have to make any more payments but you still get premium earning out so that persistency on that first sector of business is better than still very strong persistency on the third sector business. Fundamentally the guidance I gave that they will be meeting for margins and benefit ratios both between first sector and third sector is holding up well based on our experience so far and it's just a bit too early, you’ve seen the change in margin toward the higher margin third sector products. So it just takes it a while to play out the long answer to a good question but the 4% to 7% was kind of in-line with the 2013 initial guidance. Again our guidance is usually on the conservative side historically and we have usually done a little bit better than that so I’m not guaranteeing that but I’m just saying that’s historically being a factor in our guidance.

Dan Amos

I would like to say one other thing about the life product sales. We’re revisiting caps on the sales because it's interest rates have gone down. We think it's something we need to consider and we will know more about it but we’re certainly considering it for 2014 and we will let you know more at the time.

Operator

Our next question comes from Nigel Dally of Morgan Stanley.

Nigel Dally - Morgan Stanley

Quick follow-up on the assistance cost. I think a lot of investors are wondering why the CVP cost weren’t incorporated into your comments back at Investor Day. If you can bring development in this program now for several years, did you expect those cost that to be absorbed in the regular budget and you’re giving that more precise and how much is it going to cost, any color there would be very helpful and also just on another question on the U.S. I understand your private exchange is in test mode but perhaps if you can also discuss a little longer term you plan to perhaps get your product on some other positive changes like that which say break us into steps. Thank you.

Dan Amos

Nigel I will make some comments on the CVP project as I said initially we’ve been trying to observe the cost of that into our general operating expense for as long as we could. During the early to middle part of 2013 we basically finalized a plan that have been through a couple of iterations both with the project administrators and executors that were using as well as with outside consultants that were used in this program. We finalized that plan pretty much during the middle part of 2013 and got a much better handle on the plan we’re going to use to proceed and so we had a more certain estimate of cost after we completed the plan and actually that was our replan that we went through. So we have been doing a lot of work on this, we have been doing a lot of internal cross examination to make sure we have the value proposition correct and that we’re committed to go on forward with it and now we’re at the point where we do believe we have a value proposition correct. We do have good cost estimates going forward. Let me see if Tohru wants to add anything to that but essentially that’s it from my perspective.

Paul Amos

Yes. The only thing is that during the basically the planning stage, we have been able to absorb the cost within our general expenses. And as Kriss mentioned, it was in the third quarter of this year when we finalized the plan for the whole program at which time we became able to communicate our plans more clearly to the outside world. So yes, and so like I said that until 2013, we were able to absorb the cost within the general budget, but that asset the program going into the full implementation stage that is the amount of the cost to exceed the range we can absorb.

Dan Amos

And Nigel, I would add this comment, we have constantly reassessed priorities and the ability to change the products and premium rates on the per sector products that became a much higher priority, one that we felt like have the economic impact to justify the increased expenditure going forward. So from an investment point of view, we thought okay, this is an investment we need to make to protect our future financial position.

Ken Janke

Nigel, this is Ken. Let me comment briefly on your exchange related question. Dan has indicated that we are in the process of piloting the Aflac private exchange which referred to as Everwell. It actually just started last week. So we have had several cases built in a very limited number of markets, but we don’t have enrollments occurring yet. It was our decision when we began down this path to take a very conservative and pragmatic approach to the market with the rollout of the exchange. We want to make sure that it meets everyone’s expectations, the agent’s expectations, the expectations of the employer as well as the employee and also us internally. So we prefer to go a bit slower as we launch this. So we are piloting in three states. If all goes well, we would expect a schedule rollout next year, but the purpose right now is really for the 50 and under case size market. So, it’s a very targeted market for the Aflac private exchange into – a couple of years from now to likely go up to a 100, but the private exchange will primarily be for the small case market. Your question about Aflac products appearing on other exchanges that is something that we are evaluating currently, but it’s really taking for right now at least a backseat to the efforts we are taking to get the AFLAC private exchange rolled out properly.

Nigel Dally - Morgan Stanley

It’s great.

Dan Amos

And those states Nigel are Texas, Georgia and Illinois.

Nigel Dally - Morgan Stanley

Great, thanks a lot.

Operator

Our next question is from Jimmy Bhullar of JPMC.

Jimmy Bhullar - JPMC

Hi. I had a question first on the reinsurance agreement that you singed in Japan, could you just discuss the mechanism of the contract how it works and I don’t think it affects FSA or GAAP results, but you could mention that as well? And then like you have the potential for more and under what circumstances you might consider additional contracts, the only other one I had was on the U.S. business and there has been a lot of talk about healthcare reform. How much do you – longer term, do you see this as more of an opportunity or a threat as it affects the supplemental products market in the U.S.?

Dan Amos

I will take the first one. I have always believed that with change comes opportunity. What better example then we go back to 2001 with Japan and realized that everyone thought we were dead, we were in trouble. Cancer insurance was going to be taken away by the big life insurance companies. Three months after the initial deregulation, we were the number one seller of medical insurance and still hold that to this day and now have cancer insurance have continued to be number one. We are positioning ourselves that we will be – continue to be the number one insurer with supplemental health insurance products. I believe our ability to be able to do exchanges, our ability to be flexible because of relatively low price products, I believe it's going to stand out more because different plans that are being offered bronze, silver, gold and I think it's pretty clear the vast majority of people are going with the bronze plan it's going to be offered. That means it's going to be a very defined amount of out of pocket expenses to consumers which plays well with us. Also our brand our name recognition is now it's hit 94% no one that is in the market today even though there may be other companies that have reasonable brand awareness not to our level but they are not seeing as being “supplemental health products.” So I think we’re in a great position, I’m excited about it there is uncertainty make no doubt that’s out there today but that too will pass and when it passes we have to be ready and to go in a way that I think will accelerate growth for us and we’re counting on that. When and where and how it will do as I mentioned consumer confidence is down, that hurts us. Other areas people that want to procrastinate are always looking for excuses they can use right now. I want to wait till everything is finalized with national health plan but all in all I don’t think I would swap places with anyone in the industry in terms of being prepared for healthcare as we are right now.

Now the other question, who wants to take that?

Kriss Cloninger

I’ll take that, that’s all about the structure of the co-insurance agreement and some related questions. Jimmy the reinsurance agreement is co-insurance in nature with a third party reinsured that’s authorized for reinsurance in Japan. We co-insured portion of one of our more established predictable, profitable blocks of business. It's a no-cash transaction upfront going forward we will see the portion of the premium income from that block, net of an expense allowance we receive from the reinsurer and reinsurer will reimburse us for the proportionate share of the claims on the business. So it's a pretty straightforward agreement. But because the reinsurance is permanent in nature we’re allowed to take a reserve credit in say financials for the pro rata share of FSA reserves on the block and the amount of those reserves we get a credit for is approximately a 100 billion yen.

You know based on the difference between the premium we pay and the claims we expect to receive there is a net cost associated with agreement and I indicated what that is, it's anticipated to be about a nickel a share in the 2014 GAAP financials. As far as U.S. statutory treatment the reinsurer is not an authorized reinsure in the U.S. so we will report our U.S. statutory earnings based on the co-insurance being an effective agreement in terms of stated premiums and claims but we will not admit the reserve credit. So we won't get any surplus relief on the U.S. statutory statement or the risk based capital measure but that didn’t trouble because our RBC is already strong enough and we didn’t feel like paying the extra cost of you know that it would take to get the reserves backed by letters of credit and authorized for you know surplus recognition in the U.S and on a GAAP basis nowhere I mean we’re releasing some reserves but we’re putting but a deferred profit liability amortizing the cost in accordance with the accounting requirements and you know again the net cost is what I indicated.

Jimmy Bhullar - JPMC

Okay, thank you.

Dan Amos

Going forward, you ask again about additional capacity, we believe we do have additional capacity, but I will say that I view this as a sale of a portion of our business and it’s not an action we would enter into lively compared to say a financial reinsurance transaction, where you are basically getting a loan and paying it back over a period of time. This is more of a permanent transaction and not something that I would enter into routinely. Regarding capacity, I think we do have additional capacity, but it’s not something we are going to look at quarterly and see where our SMR is and say okay, do we need another $2 billion reinsurance this quarter? That’s not what we are going to do.

Jimmy Bhullar - JPMC

Got it, thanks.

Operator

Our next question is from Tom Gallagher of Credit Suisse.

Tom Gallagher - Credit Suisse

Good morning. First question is Dan, did I hear you correctly that you said you were reconsidering the limits that you have on (indiscernible) sales, just wanted some clarification on what you had mentioned there

Dan Amos

That is correct. What I have said is that with interest rates moving lower, we adjusted put limits last year and this year. We are looking at them again now for ‘14. So even though, our productions weigh down we still could have limits even more so. So we are monitoring that and seeing what we need to do. And we are not the only ones in the industry doing that. So it’s not limited as this does. Other companies are doing that as well.

Ken Janke

Basically, this is Ken, the price increase that we implemented for first sector products in effect became a production cap, because they were the primary distributors moved out our products, but with interest rates declining again in Japan, we don’t want to repeat a 2011, where our other companies put in production caps and all of a sudden we have become more attractive product in the marketplace. And so you can still make this a good profit margin product investing in JGB, so I assume the pricing has been dramatically altered then.

Dan Amos

Well, it was dramatically altered April 1 when we increased the pricing of the product to recognize the 1% standard valuation interest rate in Japan, we basically re-priced first sector products at 1.25%, but still even at that level though we have got profits in it, we are trying to minimize the low margin products emphasizing the higher margin third sector products.

Kriss Cloninger

And since April the deals in Japan have declined further.

Dan Amos

That’s correct.

Tom Gallagher - Credit Suisse

Great. And just one question related to your capital return program, Kriss when we think about the I guess what annualized you are almost at a $700 million level for common dividends and the buyback for next year expected to be $800 million to $1 billion, should we think about that being a level as you move forward into ‘15/16. Is that just based on the way you have optimized things? Is that – should that be a fairly consistent amount of capital return? Do you think that’s going to go up materially or you are kind of overspending, how – can you frame how we should think about what you have done now and what that would mean more prospectively?

Kriss Cloninger

I wouldn’t say it’s overspending at all Tom. We are not pulling down additional capital from Japan to invest in share repurchase. You know that historically our profit repatriation from Japan has been somewhat highly correlated with the FSA basis earnings and we have been trying to make sure that we achieve some stability in those FSA basis earnings. On average, probably over the last 10 years, we have taken out about 80% of our FSA basis earnings as profit repatriation and lot of that gets allocated to the share repurchase activity. In various specific years, we have gone around 50% or 60% of FSA earnings. And in one year, we took out 100%, but in general, there is going to be high correlation between profit repay creation and FSA basis earnings and our guidance is based on the notion that we’re going to be able to stabilize FSA earnings and the increased repay creation would kind of be a normal increase associated with recognized FSA earnings you know and then the common dividend and the share repurchase it roughly you know approaching 2 billion a year is what I would consider kind of a normalized run-rate not excessive or not supplemented in anyway but other than normal earnings.

Tom Gallagher - Credit Suisse

So approaching 2 billion meaning you could have another 500 million or so of upside as you think about it going forward?

Kriss Cloninger

Well we have given the 2014 guidance but you know as you said you know thinking about round numbers I mean we’re between a 1 billion and a 1.5 billion and what comes next which in my mind is 2 billion so as I think about 2015, 2016 you’re probably heading in that direction.

Dan Amos

And let’s be clear, no one has to make it clear to us that that’s what our shareholders want us to do. We got the message and that’s what we’re doing. We’re moving that way and that’s why this call and these things that we’re doing. This is our number one priority because that’s what our shareholders believe will ultimately enhance the value of our shares.

Operator

Our next question is from Joanne Smith of Scotia Capital.

Joanne Smith - Scotia Capital

I just wanted to ask if you could just clarify the last statement that you made Kriss in terms of the profit repay creation. Did you just say that you were moving towards 2 billion?

Kriss Cloninger

Not all profit repay creation by itself but I was including the payout to shareholders including common dividend which is approaching 700 million and you know a $1 billion say of share repurchase in 2014 which be expected to increase somewhat over the next several years. And we should have said the number but in my mind it's kind of in the range of where I’m shooting for.

Joanne Smith - Scotia Capital

Next question on the U.S. sales and Japan sales I guess, in the 2014 guidance there was no guidance for what you’re looking for in terms of sales growth and either the U.S. or Japan. With the weak sales in the U.S. in the third quarter I was somewhat surprised that you did not change the 0% to 5% target for the full year and with the pick-up in sales in the third quarter in Japan I’m little bit surprised that you haven't gotten more comfortable providing guidance for 2014. So can you just address those issues please?

Dan Amos

I will let Paul do Japan then I’ll cover the U.S.

Paul Amos

Overall you know obviously we don’t know where we’re going to finish this year with the strong momentum that we have in the third sector due to the new product launch in the middle of August. It's hard for us to tell exactly how we’re going to finish the end of this year. However we do believe it's going to be at the high end of the range that we have given 0 to 5 but at this point as Dan mentioned there are quite a few factors going on all the sales projects for next year whether we put in caps on first sector products whether we you know what products we’re going to launch in terms of next year and having in the third sector. We do feel third sector is going to be continue to be the emphasis but at this point we just can’t give you a strong range, what we will do though is in the fourth quarter at least give you those numbers and that’s what we have traditionally done even though we have given you the earnings release previously we have given you the sales projection at the end of the fourth quarter and that’s exactly what we plan to do to remain consistent with years passed.

Dan Amos

And as far as the U.S. goes I never like to say we’re not going to achieve an objective but I think the headwinds that we have had regarding uncertainty in this fourth quarter gives me pause [ph]. So I would not say that I’m optimistic but I do believe once this calms down that again where there is change is opportunity and I believe that we’re going to get it together. The main thing I’m trying to do right now is to concentrate on getting it right for healthcare reform. And Teresa, who is our Chief Operating Officer at Columbus and Dan Lebish who we put as the Chief Operating Officer of Columbia with group insurance and Ken overseeing all of it. We are coordinating to make sure we do these things right to handle and be ready. And so that has been my emphasis for the remaining of this year. Our director sales, their quotas are still based on the numbers that we set. There is no lowering or anything. So they are all pushing as hard as they can, but as I said, I am not as optimistic we will achieve that, but I am going to say never till the end, because with group insurance and other things, big things can come through, so we will watch it and see.

Joanne Smith - Scotia Capital

Okay. And then just one last final question and that is on the deductible in Japan, what level of confidence do you have that there is going to be structural changes that occur in Japan and that would include an increase in deducting the deductible on the national healthcare programs? And what kind of timing would you be looking at?

Dan Amos

Well, you remember that I said it was going to 50% 10 years ago. I said, well if it went to 0% to 10% to 20% to 30%, I didn’t see any reason it wouldn’t eventually go to 50%. Well, my answer is I am already behind, because I thought it would have happened by now on some of it. Now Paul is over there and maybe to (indiscernible) comment on.

Paul Amos

I would just say that obviously it’s the third pillar of (indiscernible), he has had great success in some of the implementations thus far. And I think it’s difficult to ever predict what’s going to go through a political system whether it’s here in the United States or in Japan. The fact is however the population demographics continue to push in such a direction as well as the overall Japanese consumer sentiment about the healthcare program in general. And you have seen them already talking specifically about raising the co-pay for ages 70 to 74, I don’t know if Tohru wants to chime in on this, but I think in general, it’s very difficult to us to commit anything that’s outside of our control. Obviously if it were to shift to a 40% or 50%, it would be a positive tailwind for us. Tohru?

Tohru Tonoike

Yes, this is Tohru. I think I agree with Paul about the prospects of the co-pay for the elderly people between 70 to 74.

Joanne Smith - Scotia Capital

Okay, thank you very much.

Operator

Our next question is from Randy Binner of FBR Capital Markets.

Randy Binner - FBR Capital Markets

Hi, okay, thank you. I will keep it brief since we are at the top of the hour, but just on the buyback this quarter now is pretty significant at $500 million, so just want to clarify that you have not executed on any of that so far when the blackout period for that is over and if you have any special execution plans to get that done this quarter given the size?

Ken Janke

Randy, this is Ken. We typically move out of the blackout period after in the afternoon of the daylight today after the conference call when we know all of the news has been properly disseminated. We have evaluated not only our capital position, but trading volumes and restrictions that we have for purchasing on a daily basis and we are confident that we can execute those purchases in the fourth quarter.

Randy Binner - FBR Capital Markets

Okay.

Dan Amos

So we hadn’t bought any so far and after 12 o’clock today, 1 o’clock we can be in the market.

Randy Binner - FBR Capital Markets

Okay, great. Yes, that would be good. And then just one other quick one, just a follow-up on the reinsurance transaction, is it – when you say it’s prominent how prominent is that? I mean, can you get out of it or is this, I am just kind of curious what the definition of permanence is there?

Dan Amos

Well, there is recapture provision in there. I suspect if we negotiated with assuming company we might be able to do something, but that’s not our intent. We intend to let it play out over time as I said albeit more as a sale of a block of business than I do shorter duration reinsurance arrangement that can be recaptured.

Randy Binner - FBR Capital Markets

And is this counterparty, can we take it as the Japanese insurance company?

Dan Amos

It’s an international insurance company that operates in Japan.

Randy Binner - FBR Capital Markets

Okay. And then one last one just detailed question, you outlined there is $0.05 of EPS cost for the reinsurance deal, where does the hedging piece such as the rate collars fit in, is that in that $0.05 or is that somewhere else?

Dan Amos

I don’t have anything to do with that. This is strictly a claims reinsurance, didn’t have anything to do with interest rate hedges on assets. There is no asset transfers involved. We remain responsible for all the exchanges and the investment income on assets back in the block, it's strictly claims released and exchange for the payment of gross premium net of an expense allowance.

Randy Binner - FBR Capital Markets

I guess what I’m trying to say what is the callout then on the interest rate colors, is there a cost in the kind of the list of headwinds to ’14 EPS?

Dan Amos

There is zero cost color but there are settlements depending on where rates move to. But the estimate is zero.

Rob Wilkey

Okay Marianne as Randy pointed out we’re past the top of the hour. We’re going to take just one more question.

Operator

Thank you. Our final question comes from Steven Schwartz of Raymond James & Associates.

Steven Schwartz - Raymond James & Associates

Can we revisit CVPs follow-up, CVP the $0.12 that you’re the increased $0.12, what is the total amount that you’re spending on this in ’13?

Kriss Cloninger

Tohru might be able to answer but what we’re addressing here is the incremental cost over 2013. Actually you know the way you measure cost we have had a lot of discussions with Aflac Japan personnel and you know it's whether you go through a fully absorb cost and all that kind of thing and I don’t want to get into that on accomplished goal. So I will just say that EPS the guidance is the excess direct cost that we intend to invest in the CV program over what we invested in 2013, however that number was derived.

Steven Schwartz - Raymond James & Associates

A question on the reinsurance, in the long run does the historical ratio of the amount that you repay relative to FAS earnings, does that change it at all because of this?

Kriss Cloninger

Well we’re not, we will get to count the reserve release as part of FAS earnings. However we are leaving the reserve release in Japan as part of our capital base. We’re not going to repay three any portion of the profits triggered by the reserve release associated with the reinsurance agreement. So if you just look at reported FAS profits, they will be significantly higher well by about a 100 billion yen than they would have been without the agreement and we don’t plan to take any of that out. We plan to generate capital with this transaction and we couldn’t achieve that purpose if we repay created that portion.

Steven Schwartz - Raymond James & Associates

Okay how about in ’15 and ’16?

Kriss Cloninger

I’m relying pretty much on routine FSA operating earnings which will not be benefited in any extraordinary way by the reinsurance agreement. There will be a routine cost in the FSA earnings approximately of the same amount that impacts U.S. GAAP earnings as I indicated. There will be a difference between the premiums net of allowance is paid and the benefits received, that will probably a net cost of reinsurance that will go through 2015 FSA earnings in addition to GAAP and staff [ph] but that’s not material compared to you know what we’re talking about on the initial reserve release associated with the transaction.

Steven Schwartz - Raymond James & Associates

Okay and then one more if I may, with Paul moving to Japan what is the chain of command in Japan these days?

Dan Amos

Well the operating will still be run by Tohru. He is still the Chief Operating Officer and in charge. Paul is not going to be living there for the rest of his life. He is just moving over there for a period of time, six months to a year whatever it ends up being just to better understanding, Paul speaks Japanese. He will just be over there learning the culture more, being associated with them, building relationships with them and giving him a better understanding of exactly how it works and they all get along very well and I am very pleased with how that’s going just as I am pleased with Ken and what’s going over there and the job that Teresa is doing. I think all-in-all, this has been a very smooth transition and just allows flexibility for you to understand our management team and let them be able to be able to do cross jobs and do different aspects up.

Steven Schwartz - Raymond James & Associates

Okay, thank you guys.

Robin Wilkey

Marianne, thank you very much for about 15 after the hour, if anyone wants to follow-up after the call, please call Investor Relations and we appreciate your participation on the call. Thank you.

Operator

This does conclude today’s conference call. You may disconnect your phones at this time.

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